An interesting analysis of the prospects for gold from Ambrose Evans-Pritchard this week. Along the way to his conclusion he does a nice job of stating the cases for inflation and deflation.
He starts out by noting that the Chinese have substituted gold for some of the paper they could be buying from the West and also touches on John Paulson’s big move into gold and his new real estate oriented fund. Evans-Pritchard sees Paulson’s moves as a reflation play. Others have made the same observation and it probably is an accurate depiction.
He points out that Paulson and others of his age — early 50’s into their 60’s — may well be drawing on the experience of the 1970’s. That may be a bit relying a bit too much on psychology but it is true that our views are shaped by prior experience and that often is the prism that we fall back on in times of stress. Probably a good reason why so many of us fail to predict the outcome that ensues.
On the other side of the argument are those who either had experience with or are students of the Japanese experience. This group sees deflation as the primary risk and is concerned that it might well become a chronic condition. Essentially all of the stimulus that the West is pouring into its economies is just being used to offset tremendous deflationary pressures.
Evans-Pritchard is in the deflationary camp. He feels that the likelihood of a Japanese outcome is the most obvious, yet he’s also a gold bug. Here’s how he rationalizes the dichotomy:
Personally, I remain a gold bug out of fear that the most corrosive phase of this crisis lies ahead. There are two more boils to lance: Europe and China. As the IMF keeps telling us, Europe’s banks are still covering up their vast toxic debts. Nor has the G20 begun to address the root cause of the global crisis, which lies in excess exports from East (aided by currency manipulation) to an over-spending West. China is putting off the day of reckoning with its crisis response, which is to build yet more plant to flood the world with yet more over-capacity.
For “political bears” the risk is that the EU polity fragments under strain, and that governments restrict basic markets to defend themselves – whether by imposing exchange controls to stop bond flight, or shutting derivatives markets used as hedges, or putting up trade barriers. We will find out if and when unemployment hits 10pc in America, 12pc in Germany, and 20pc in Spain, or if migrant workers rampage in Shenzhen.
Some call this the “Armageddon case” for gold. That is going too far. However, gold has outperformed Wall Street’s S&P 500 index by 500pc so far this century, as if able sniff out trouble in advance. Such runs tend to finish with a “parabolic” blow-off before they die. Mr Paulson may yet make another fortune, whatever his reason.
He may not think that it’s an “Armageddon case” but it sure looks like one to me. While the events he postulates may ensue, I think the probability of that happening is low. In this case, Evans-Pritchard ignores, I think, the very real progress that has been made since last fall. That’s not to say that land mines aren’t out there, I just think that if one or two do blow up things are under sufficient control so that the damage will be controllable.
Having said all of that, I think that any prudent person would have at least some gold in their portfolio just in case. Look at it as a hedge against either Evans-Pritchard’s scenario or an explosion of inflation but for my money the best play is one that anticipates the Japanese outcome.